Friday, May 23, 2008

Life Time Value

A customer’s Life Time Value (LTV) is based on a common management process of discounting future values or revenue flows by a discount rate so they can be compared with cost outlays to decide if we stay in business doing some action or another. Spiller and Baier discuss Life Time Value on pages 18, 75-76.

Group 3 (see Foreman, 2002) holds that LTV analysis is no longer relevant “because it’s difficult to focus on speeding bullets.” They further assert that with modern interactive technology, “a better price, better service or a wider selection could be just a keystroke away. This makes customers less committed, not to mention completely undermines the LTV model.”

My first thought about less committed customers is the discount rate would reflect the risk of lower future revenues caused by this diminishing commitment. It also struck me that discounting future revenue streams is standard financial business practice that has spread to IMC.

When dealing with other people’s money, such as shareholders or other investors, we incur a fiduciary responsibility. To protect our stakeholders and ourselves we follow standard business practice unless we think we can make a better case for not following it that will hold up in court if it comes to that. Muir and Schipani (2007, p 2) also remind us that in addition to tort action, “regulatory use of finance theory” is now part of the corporate governance mandated by Sarbanes Oxley (SOX). SOX was passed to keep investors from getting fleeced by fountain pen conspirators masquerading as management.

The argument Group 3 is making, by my reading, is that because of the rapid change in the competitive landscape, future revenues will be less than expected. Their implicit assumption is that management cannot distinguish service or product from competition except by price and hence the dismal outlook for future revenues. It is not at all certain, however, that competition alone reduces us to fungible commodities. It also takes management believing that it has no other chips to play, such as improved marketing communication, superior customer service and the like.

Pine and Gilmore (1999, pp 1-3) show that exactly the opposite will happen when management has a more positive outlook and distinguishes the product or service of its company. They use coffee beans as the ultimate fungible commodity. They trace the costs through a brutally competitive minefield and Burger King has a low cost offering of Dewey Egbert coffee at $1.19 per cup. Yet Starbucks manages to sell an equivalent cup for $1.79. The difference is the creative work invested by Starbucks to improve the customer experience that allows them to charge a 60% markup over their competitors. We need to avoid making the ruinous assumption that competition results in a rush to the bottom with utter destruction of revenues.

On the other hand, social media is demolishing the business world. The Boston Consulting Group, in their Harvard Business School publication examines the impact new information technology is having on business strategy. The authors of the work, Evans and Wurster (2000, p 72) describe the disintermediation wrought by the new media as a “technology [that] allows for the richness/reach curve to be displaced, allowing new players to offer greater reach and greater richness simultaneously.” This results not in a re-segmentation of the old business but in an industry transformation to a new model. New models may very well not use the traditional practices of today, although this is only a possibility.

Evans, Phillip and Thomas Wurster (2000). Blown to Bits. The Boston Consulting Group. Harvard Business School Press.

Foreman, B. (2002) Are Lifetime Value (LTV) models outdated in the new world of global marketing? Group 3 Marketing. Retrieved August, 28, 2008, from

Muir, D. and Schipani, C. (June 2007). ARTICLE: THE USE OF EFFICIENT MARKET HYPOTHESIS: BEYOND SOX. Michigan Law Review. Retrieved on August 29, 2008 from LexisNexis.

Pine, J and J Gilmore (1999). The Experience Economy. Harvard Business Press.

Spiller, L. and M. Baier (2005). Contemporary Direct Marketing. Pearson/Prentice-Hall.

No comments: